Rising tension as China weighs a double dip

WangXu

WangChangyong

BEIJING (Caixin Online) -- Nerves started fraying for a Shanghai property developer named Xue just a few weeks after he scraped together several million yuan from family and friends for a private, high-interest loan to a Wenzhou electrical equipment company.

Xue had expected substantial returns after the borrower agreed to a 30% interest rate and signed the loan deal last November. But his optimism started fading fast when interest rates for private loans began to rise, bank credit tightened, and the government introduced new real-estate market controls that affected his core business.

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Meanwhile, Wenzhou business owners started comparing conditions in late 2009 to the second half of 2008, when local companies foundered in the global financial crisis and private borrowers failed to repay.

Sensing trouble, an anxious Xue called in the loan. In so doing, he acted on increasingly cautious sentiments -- and sometimes confusing signals -- surrounding China's latest economic trends.

Since at least mid-April, investors have lowered expectations for commodities and stock markets. Prices for non-ferrous metals and other commodities have fallen from highs posted earlier in the year, and the Shanghai A-share market index declined 19.5% between April 15 and June 4.

Government measures in the first quarter pinched some sectors, as regulators sought to prevent overheating, especially in the real-estate industry. Debt controls were ramped up for local government funding platforms, affecting local investment behavior.

The changes that Xue sensed in December were generally hidden behind strong first-quarter statistics for China's economy. But by April, the party was obviously over.

"April and May saw important changes for domestic and foreign policy, as well as financial trends," said Ha Jiming, chief economist at China International Capital Corp. (CICC).

And rising concerns that the global economy may be headed toward the second trough of a double dip have further underscored the challenges to China's future growth.

Property squeeze

A State Council decision April 14 to tighten property-market controls was the first in a series of policy moves affecting loans, land auctions and new construction. Housing prices cooled as hoped, but so did the market and investor sentiment.

Another round of controls came in late May, when the State Council outlined a plan to gradually introduce property taxes.

The cooling for real estate also slowed overall investment. Leading the turnaround were stricter bank lending policies that started in March.

China Index Research Institute data indicated that many potential investors started taking a wait-and-see approach to housing purchases in the wake of the regulatory policies. As a result, the combined property area sold in China's major cities fell about 44% in May from last year, which in turn lowered overall investment levels.

Urban fixed-asset investment officially grew 26.1% during the first four months of the year, 4.4 percentage points below the growth posted the same time last year and down 0.3 percentage points from the first quarter this year. But these figures reflected substantially higher prices, not the physical volume of fixed-asset investment, which grew at a much slower rate.

According to CICC analysts Xing Ziqiang and Xu Jian, April's real investment growth probably declined to 19% -- far below the 38% tallied in December 2009. Likewise, the number of new construction projects was expected to fall substantially through 2010.

Wang Binqing, a real-estate industry researcher at Century Securities, said he now expects new construction starts to decline 23% month-on-month in April, although the year-on-year figure jumps nearly 72% for the same month.

For developers such as Xue, the affects of real-estate regulation have been apparent. "After just a few short months," he said, "I already have friends who can't start projects because they can't get loans."

And not only developers are worried -- the real-estate industry has a powerful impact on market sentiment nationwide, since property investment accounted for 12.8% of China's gross domestic product last year, as well as 22.1% of all urban fixed-asset investment.

Local slowdown

Just as real-estate investment was slowing, local governments started reducing their investments on infrastructure and other projects through government funding platforms. The spending stream narrowed after the China Banking Regulatory Commission (CBRC) ordered commercial banks to clean up and consolidate loans to platforms.

Beginning in the second half of 2009, CBRC and the central bank had investigated funding platforms. They planned to unleash new platform management practices in May, but had to delay after local governments complained.

Less investment by local governments, as well as in real-estate, were just what the central government was looking for to counteract concerns of overheating in the national economy -- concerns exacerbated by an 11.9% increase for China's GDP in the first quarter.

However, experts say if investment restrictions continue along with weak foreign demand for Chinese exports, growth may falter. A soft real-estate market would put even more pressure on Chinese investor outlook.

A new engine?

Might a new growth engine be waiting in the garage? Some say an increase in affordable housing construction this year could serve as a hedge, averting a slowdown for real-estate investment growth and helping to keep overall economic growth at least at 2009 levels.

"Over the next 12 months, the government will take relatively significant action on low-rent housing," predicted Lou Gang, a China strategist at Morgan Stanley.

Recent policy moves supported Lou's prediction. On May 19, for example, the Ministry of Housing and Urban-Rural Development signed a commitment with provincial and city governments to add a record 7 million affordable units this year. Some 5.8 million new, affordable homes would be added to the nation's housing stock, and 1.2 million substandard homes would be renovated.

Assuming each home averages 60 square meters, those 7 million additional homes would equal 420 million square meters, an area equal to 36.5% of the new construction nationwide last year.

Deputy Director of the State Council Research Institute of Finance Ba Shusong said strict accountability mechanisms have been put in place at the local governments to guarantee the target is met.

And real-estate controls may be loosened in the second half of the year with a possible easing of credit restrictions on government investment.

While in Tianjin in mid-May, Prime Minister Wen Jiabao said China "must focus on macroeconomic policy coordination and regulate the overall adjustment control efforts, while also preventing negative effects from the overlay of the number of policies."

A key goal, the premier said, is "to always have a reasonable grasp of the intensity of the policies."

These comments prompted some analysts to predict more fine-tuning for policies originally implemented to tighten credit and investment. Indeed, municipal and local bond sales were quickly approved by the central government, giving veracity to this opinion.

On May 14, the Ministry of Finance said the central government had allocated more than 24.8 billion yuan ($3.6 billion) for rebuilding in earthquake disaster zones in Sichuan, Gansu and Shaanxi provinces. Emphasis was placed on city and town infrastructure, public services, disaster relief, industrial reconstruction and other projects -- some 4,000 projects in total.

Over the past half-year, the Ministry of Finance has allocated all disaster reconstruction funding. In early May, municipal bonds for Anshan, Ordos, Fushun and other cities were approved and successfully issued.

An analyst at China Chengxin International Rating Co., who worked on municipal bond ratings, told Caixin the municipal bonds had stalled after being filed with the National Development and Reform Commission (NDRC) early this year. "We don't know why they were never approved, despite constant pressure," he said. "But recently, more than a dozen were approved."

Altogether, officials have started to distribute 200 billion yuan in local government bonds managed by the finance ministry. They're being divided among every province, municipality, district and designated city.

An economic development official at the finance ministry told Caixin the local bond issuance plan had been ready for some time but was waiting to be released at an appropriate time.

"First-quarter economic growth was so high, how could the government further speed up investment?" he asked.

Last December, the National Audit Office said 9 billion yuan in local government funds designated by the central government for projects aimed at expanding domestic demand had yet to be committed. These represented 45% of these project funds.

But the latest slowdown period was apparently the appropriate time.

"If real-estate investment is to come down, there needs to be a supplement," said Zhang Hanya, an NDRC researcher. "In general, this year is about controlling new construction projects and guaranteeing current projects. But some reconstruction projects last year lacked local money and were not completed."

"So it's best to give local funding platforms some degree of comfort," Zhang said.

Gao Huiqing, a member of the State Information Center Expert Committee, said the slow pace of municipal and local bond issues at the beginning of the year are now weighing on local funding platforms, raising credit risks and risking economic decline.

"But the government doesn't want to see a bunch of unfinished projects," Gao said. "Therefore, it is a controlled pace, not a complete block."

Foreign caution

But the European sovereign debt crisis is out of the government's hands, prompting a cautious outlook toward exports. Even Wen Jiabao is raising a red flag.

"Some say the global economy has already recovered, and now we can consider exit mechanisms," said the Chinese premier May 31 at a luncheon sponsored by the Japan Business Federation. "I believe this judgment is premature."

"We cannot be 100% certain" that the global economy will not experience a second dip, he said. "So we must closely watch and take precautions against such risks."

Some analysts think the debt crisis that began in Greece will spread to Spain, Portugal and other southern European countries. As these countries weaken, consumer demand for Chinese goods may soften as well.

At the same time, a debt crisis may intensify a devaluation of the euro against the U.S. dollar and yuan. This could further affect China's exports. So far this year, the yuan has appreciated 15% against the euro, putting more pressure on Chinese exporters.

"Devaluation of the euro will certainly seriously affect us, but we haven't seen it yet," said Kang Quan, international affairs manager at a cable manufacturer in Shenzhen.

"This year's pre-September orders were all made at the end of 2009 or the beginning of 2010," he said. "The effect of the euro's devaluation will be apparent in the fourth quarter this year and the first quarter next year. And the seesaw in prices over the next few months will be difficult for both buyers and sellers." See this report on Caixin Online.

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